Egypt Builds a Wall with Gaza

Welcome back to SovereignBeat!

In this publication:

• Egypt builds a wall with Gaza

• Sri Lanka pushes for restructuring, others try to follow suit

• Central banks opting for gold over the dollar

• Japan’s main equity index Nikkei races to fresh 34-year high

• Fed needs a few more months before considering cuts

Let’s dissect

Markets Snapshot

Debt Securities

• Federal Reserve Governor Christopher Waller stated on Thursday that he would require "at least another couple more months" of data indicating a sufficient decline in inflation before considering interest rate cuts. Although Waller anticipates the Federal Open Market Committee to initiate interest rate cuts later this year, he also acknowledged "predominately upside risks" to his expectation that inflation will reach the Fed's 2% goal. Initial data indicated a moderation in US private sector growth in February, marked by a noticeable slowdown in service sector expansion and a modest uptick in manufacturing output.

• Anticipating a delay in interest rate cuts by the Fed until June raises the likelihood of the BoE and ECB taking the initiative to reduce interest rates first. With the eurozone's modest 0.5% growth in Q4 2023 and declining inflation rates, the ECB may find a conducive environment to contemplate interest rate reductions, contingent, again, on a further decrease in inflation.

Equity Markets

• Last week marked a historic day in Japan as the Nikkei 225, the most important domestic stock index, surpassed its all-time high after a 34-year wait! This exceeded the record level reached during the country's asset bubble in 1989. The index, representing the largest Japanese companies, closed above 39,000 for the first time ever, reaching a closing level of 39,098. One of the sales trader described this as the "psychological closure everyone wanted."

• Goldman Sachs raised its year-end target for the S&P 500 to 5,200 from the previous estimate of 5,100 in December, reflecting roughly a 4% further upside from current levels. This upward revision aligns with the overall positive sentiment in the market since the beginning of the year, driving stock prices higher. The optimism is fueled by robust economic growth and inflation data.

Commodities

• Oil: Brent crude prices spiked above USD 82.5 per barrel on Thursday, propelled by a Houthi attack on two US ships in the Gulf of Aden, before rebounding to the 80-dollar territory. Market focus also revolves around OPEC+'s March decision on extending output cuts. The International Energy Agency (IEA) highlighted a global oil demand slowdown as the transition to renewable energy gains momentum.

• Gold: Central banks in China, Russia, and Turkey are strategically increasing their gold reserves to reduce dependence on the USD. The share of gold in international reserves has reached about 10%, with USD holdings declining to 60%, according to the IMF. This also aligns with the BRICS bloc's efforts to decrease reliance on the USD.

Global Finance

Sri Lanka Submits NEW Restructuring Proposal

• Sri Lanka has submitted a fresh restructuring proposal to dollar bondholders in its efforts to complete the overhaul of its defaulted debt. This serves as a counterproposal to a previous offer from a bondholder group in October, which was rejected and involved a 20% haircut along with the issuance of macro-linked bonds. The details of the new proposal have not yet been disclosed

• Completing the restructuring of Sri Lanka’s $27 billion of foreign debt is crucial to maintaining the flow of financing from the IMF. President Ranil Wickremesinghe stated this month that authorities anticipate finalizing the restructuring within the first six months of the year. Similar to Ghana, which we previously discussed here, the government has already reached restructuring agreements with official creditors, including China, India, the Paris Club, as well as with holders of its local debt.

• Following the submission of the proposal, Sri Lanka's hard-currency bonds began posting daily gains, with 2025 notes reaching over 55 cents on the USD and marking their highest level in two years. Bonds maturing in 2029 and 2030 also experienced significant gains, positioning them among the top performers in emerging markets.

Our thoughts

• A global bond rally towards the end of last year, fueled by expectations of rapid interest rate cuts in the U.S. and Europe, prompted investors to seek higher returns in riskier debt. This increased demand for emerging and frontier markets' debt, leading to a decline in borrowing costs for those countries. Consequently, it pulled several countries out of the realm of debt distress, typically characterized by a dollar-borrowing cost exceeding 10 percentage points compared to US Treasuries. The borrowing spreads for 10 nations have already fallen below this threshold since 2022. We also witnessed the first-time issuance of eurobonds in Sub-Saharan Africa since 2022, with Cote d'Ivoire raising $2.6 billion through two bonds with respective maturities of 9 and 13 years.

• These dynamics create a conducive environment for Sri Lanka, as well as Ghana and Zambia, to resolve disputes with the creditors and finalize the restructuring. However, the recent bullish expectations of rate cuts have somewhat subsided, as the implied probability of the first cuts moved from March to June.

• Despite relatively few defaults since 2022, there has been limited inflow of funds into hard currency emerging market debt, and concerns persist about the willingness to extend loans. We believe that this situation can be partially explained by the fact that the pricing of the sovereign bonds are not indicative and are largely influenced by expectations for US Treasury Notes.

Geopolitics

Egypt Builds a Wall with GAZA

• Egypt is building a wall and leveling land along its border with the Gaza Strip in anticipation of an anticipated Israeli offensive targeting the border city of Rafah. Media footage and satellite images from the Sinai desert reveal ongoing construction of an area on the Egyptian side of the Rafah crossing, enclosed by concrete walls. The compound is part of "contingency plans" in case ceasefire talks in Cairo fail and has the capacity to accommodate more than 100,000 people according to the Wall Street Journal.

• The war in Gaza have already displaced an estimated 1.7 million people internally, according to the UN, most of them pushed south in recent weeks, with more than a million in Rafah. The construction of the wall raises fears of forced displacement and fuels expectations of an imminent Israeli offensive in the region.

• Egypt, which has not publicly acknowledged the construction but has repeatedly emphasized its opposition to the displacement of Palestinians from their land by Israel, comparing such a scenario to the 1948 Nakba, which saw the forced displacement of approximately 750,000 Palestinians. Egypt also threatened to void the 1978 peace treaty if Israeli forces invade Rafah. Under this treaty, Israel committed to withdrawing from Sinai, with Egypt maintaining the region's demilitarization, fostering normalized relations between the two countries.

Our thoughts

• Egypt aims to present this construction as a precautionary measure, prepared for a potential influx of Palestinians if such a situation arises. However, they've reinforced the border fence with a wall, reducing the likelihood of individuals on the other side passing through, unless intentionally breached or opened, and thus limiting potential refugees entering Egypt.

• The Gaza war has inflicted tremendous economic costs on both nations, exacerbating Egypt's already severe pre-existing issues, including 37% inflation, constrained access to hard currency, and supply bottlenecks. Israel's GDP already contracted by nearly 20% in Q4 2023 year on year, far worse than the initial expectation of a 10% decrease. The mobilization of 300,000 military reservists and disruptions in the daily influx of over 150,000 Palestinian workers impacted the country's high-tech economy. Egypt, on the other hand, is experiencing a severe cash shortage and is desperate for a new IMF program. The country's Suez Canal revenues have plummeted by 50% this year due to Houthi rebel attacks on shipping, prompting major shipping companies to halt passage through the Red Sea and further exacerbating the flow of hard currency to the country.

• Without taking sides, it's evident that both the construction of the wall by Egypt and potentially hosting of thousands of refugees as well as the Israeli offensive, will incur significant costs for both countries. However, the impact on Egypt is likely to be more severe, given its limited resources to support refugees unless there is direct assistance through bilateral and multilateral agreements.

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Our Further Reading Recommendations

• Gazprom sales plunged as Europe defied expectations by breaking its addiction to Russian gas (FT)

• Breakdown of Israeli economy contraction by 20% (Bloomberg)